Pension debt yielding a grim outlook for local governments nationwide

With breaking news emanating out of Washington, D.C., on what feels like an hourly basis, it’s understandable that lower-profile issues go unnoticed, and since public pensions aren’t exactly the most captivating of issues, they’re almost without an audience. 

However, as mundane as they may be, public pensions have been the cause of the downfall of many entities, like Detroit and Orange County, Calif., as growing unfunded liabilities crowd out budgets, tank credit ratings and relentlessly choke taxpayers to the point that they see no other option but to move.

All told, municipalities and states owe a combined $3.85 trillion in unfunded pension liabilities, or pension costs for current and retired public workers, but you would never be able to tell by looking at their budgets or financial reports. A large part of that debt is what Hoover Institution professor Joshua D. Rauh refers to as “hidden debt” in a newly released report.

{mosads}If you look at municipal and state government books, as reported by them, there is about $1.38 trillion of debt accounted for. Government accounting tricks and sleights-of-hand conceal much of what they owe. This also misleads credit rating agencies and creditors who often rely on the information provided by the government themselves, needless to say, the entities want to paint a rosy picture to lenders.

Rauh’s report notes that while states and municipalities claim to have balanced budgets, no budget that he studied was actually balanced, meaning they didn’t account for the ongoing pension schemes.

Dallas, Houston, Fort Worth, Texas, New Orleans and Philadelphia are all sinking under the weight of their public pension systems. Even in the tristate area, Hartford, Conn., is facing the possibility of bankruptcy.

Unlike many other cities, Hartford’s problem is two-fold. The city is facing structural debt, to put it plainly the city’s expenditures are outpacing revenue. They are also facing an immediate cash-flow problem, the city is struggling to pay its current bills.

Hartford is home to 7 percent of all of Connecticut’s jobs. As seen in Detroit, bankruptcy often means a significant decline in city services, increased tax rates, and eventually an exodus of local business and residents (the tax base).

This poses a significant problem to the state. 2014 and 2015 IRS data show that 69 percent of resident income that left Hartford County, left the state. So, the threat of the state losing the 107,000 jobs currently based in Hartford is very real.

Chicago, who’s debt is so high that it would require 19 years of city tax revenue to pay it off, has increased taxes, added new fines and fees to generate additional revenue streams, and made cuts in government spending to draw down its problem. Those adjustments are menial when compared to the city’s unfunded liabilities which increased from $7.1 billion in 2014 to a mind-boggling $18.6 billion by the end of 2015.

Chicago and Hartford are far from alone, Dallas and Houston, which both have large tax bases and diverse economies, are facing pension crises as well.

Dallas’ problem is due to pension boards concealing their investments and using unrealistically high assumption rates. When Dallas realized the fund hadn’t been bringing in nearly the amount of returns as expected, pensioners began withdrawing money, putting the city in even more of a precarious position.

Houston is slightly different. The Bayou City’s problem comes from constant underpaying into its pension systems, as well as using high return rates. Constant underpayments added up, now reaching $8 billion under conservative estimates.

Unlike many of the other cities, Houston has a pension reform plan snaking its way through the state’s legislature, although its path hasn’t been without contention. The city’s firefighters have taken to staunchly opposing the plan because of what they feel is an unfair deal towards them. At one point, pension talk was so toxic between the parties that the state representative, Dan Flynn, who was leading the pension reform effort took to twitter to threaten the firefighters, saying he would “work against them” if they didn’t drop their opposition. 

Outside of government employees and watchers, few pay attention to municipal finances and how they can impact their states. That’s problematic because, unlike the federal government, when municipal governments reach a point where immediate expenditures exceed revenues on-hand, city services begin to get cut. The first things to come to mind are parks and libraries, but also included are police patrols, fire response times, garbage collection, school staffing, permitting, and countless other city functions, things that actually impact the quality of life of residents.

Cities need to do a number of things to redirect the misguided ship that is their bleak fiscal future.

Using unrealistic rates to beef up a city’s fiscal outlook is the primary cause of the ballooning pension debt. They may not account for it, but when the numbers come in, it’s impossible to ignore it. The average rate of return used by 649 U.S. pension systems in 2015 was 7.36 percent, but actual returns only yielded an average 2.87 percent. For many cities, being off only one percentage point can mean millions of dollars.

Selecting realistic rates will increase the amount of debt reported on municipal government books, forcing them to be more transparent, but it will also give them an accurate picture of the state of their finances, and what proper revenue streams are needed to address their debt. The only way to tackle debt is to truly understand how much you have.

Another solution is to implement tax caps as in Houston, California and New York.

Houston’s property tax cap was imposed in 2004 after citizens conducted a petition drive and had it placed on the ballot. The cap prohibits, without voter approval, the city from increasing property tax revenue more than the combined sum of population growth and inflation or 4.5-percent, whichever is lower. While property owners are still burdened by annual appraisal increases, they can be sure that their property tax rate will not skyrocket.

While it provides taxpayer relief, it also forces prioritization in government. Knowing that the amount of revenue able to be collected is limited, officials tend to core government functions first, and ancillary items last. 

The debt weighing down cities and states undoubtedly affects everyone living within those jurisdictions, but too often, those who are impacted the most are the last to find out. As America discusses taxpayer relief and transparency on the federal level, the same conversation should happen in city halls and state houses.